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Social Impact Investing Will Be the New Venture Capital

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Social Impact Investing Will Be the New Venture Capital
by Sir Ronald Cohen and William A. Sahlman  |   8:00 AM January 17, 2013

During the past century, governments and charitable organizations have mounted massive efforts to address social problems such as poverty, lack of education, and disease. Governments around the world are straining to fund their commitments to solve these problems and are limited by old ways of doing things. Social entrepreneurs are stultified by traditional forms of financing. Donations and grants don’t allow them to innovate and grow. They have virtually no access to capital markets and little flexibility to experiment at various stages of growth. The biggest obstacle to scale for the social sector is this lack of effective funding models.

But the problem is not money, per se. Take a look at the social sector in the U.S. There are $700 billion of foundation assets, and 10 million people working for non-profits. These are huge numbers. Yet there are massive inefficiencies in capital allocation. Too often donors starve organizations and entrepreneurs by refusing to cover overhead. This makes it impossible for social organizations to scale. Interviews conducted in 2000 by the Social Investment Task Force in the United Kingdom, revealed what most nonprofit leaders already know: Almost all social sector organizations are small and perennially underfunded, with barely three months’ worth of working capital at their disposal. And that hasn’t changed in the last 12 years.

Compare that to the world of venture capital. If a business entrepreneur came to us with a plan for growing a new business without spending a penny on overhead, we would show him or her the door. Why should it be any different for a social entrepreneur?

We believe we are on the threshold of a major change not unlike the early days of the modern venture capital industry. In the mid-1960s and early 1970s, a new type of investment vehicle was created: the professionally managed venture capital partnership. This organizational innovation drew investment capital from institutional players like pension funds and endowments and allowed for appropriate time horizons. Soon venture capital became a core part of many economies and those bold moves changed everything. Entrepreneurship has never been the same.

Just as the formation of the venture capital industry ushered a new approach and mindset toward funding innovation within the private sector, impact investment has started to bring opportunities to harness entrepreneurship and capital markets to drive social improvement. This in time will bring much needed change to the social sector.

We’re already beginning to see innovation. People are developing new securities that link social performance to financial returns. There are new experiments — models that use the tools of finance to try things in different ways — sometimes creating income streams from novel concepts, likefunding cancer research. There are also hybrid organizations like the Acumen FundBridges Ventures and Root Capital that channel patient capital to high social return investments around the world. There are even organizations like Endeavor and Social Finance that help entrepreneurs gain access to global capital markets to fuel growth in employment and social impact.

Within the last two years, government agencies in the U.K., U.S., Australia, Canada and Israel at the national, state, or even county levels have begun exploring the potential of social impact bonds. These are financial instruments that pay an investor if the cost or incidence of something (foster care or prisoner recidivism) is reduced, with comparable or better results, than a government program. If so, the investor makes money; if not, they lose money.

As more and more examples emerge from all regions of the world — addressing issues as diverse as recidivism, drug discovery, sleeping sickness, literacy, food deprivation, and poverty — one begins to get the sense that there’s no stopping this idea whose time has come.

Things will change rapidly over the next five to ten years. If investors can find the same courage the early institutional backers of the venture capital industry found, we will see talented social entrepreneurs build large, effective organizations that move the needle on a social issue and deliver acceptable financial returns at the same time.

To get there we need success stories — like the early investments venture capitalists made in companies like DEC, Intel, Scientific Data Systems, Teledyne, Genentech, Apple and Tandem — that build confidence and unlock private capital. When investors believe they can earn acceptable returns, money will flow. And smart people will feel they can succeed because they can attract capital.

We live in a world awash with capital — some $200 trillion in financial assets according to McKinsey & Company. We also live in a world of remarkably low interest rates. If we can create instruments — like social impact bonds — that can deliver a financial return of about 7%, a high social return and limited downside risk, then we can meet two needs. We can provide reasonable returns that are uncorrelated with equity markets and attract capital to entrepreneurs who can develop innovative and effective ways of improving the fabric of our society.

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The Relationship Between Microfinance, Entrepreneurship And Sustainability In Reducing Poverty In Developing Nations

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Microfinance-African-Youths
Organization:

The African Youths Organization

Solution Description

The extent to which microfinance, entrepreneurship and sustainability are inter-related is dependent on the extent to which it addresses the economic development process for example. If we are looking for an action which will enable the poor to overcome their poverty, I would go for credit invested in an income generating enterprise as working capital or for productive assets leading to establishment of new enterprises or growth of an existing one, profit from the enterprise provides income and a general strengthening/A variety of financial institutions worldwide have found way to make lending to the poor sustainable and to build on the fact that even the poor are self employed repay their loans and seek savings opportunities. The challenge is to build capacity in the financial sector drawing on lessons from international best practices in micro enterprises and rural finance. However, ensuring environmental sustainability is equally important as sustaining micro enterprises financially. The Sustainable Financial Markets Facility (SFMF) recognizes the importance of promoting “environmentally and socially responsible lending and investment in emerging markets, thus stimulating sustainable markets and private sectors activity. The need to enhance other sustainable initiatives is also paramount thus the interrelated nature of microfinance entrepreneurship and sustainable development is evident, the extent to which microfinance, entrepreneurship and sustainability are interdependent in becoming increasingly recognized by experts in their respective fields of work assoc

How will it improve our quality of life?

The fundamental framework: The policy legal and regulatory framework that allows innovative financial institutions to develop and operate effectively. In institution building: Exposure to and training in best practices that banks and microfinance organization need to expand their outreach and develop sustainable operations, long with performance – based support for capacity building. Innovative Approaches: Leasing, lending and other products to increase access of small and medium size enterprises to financial services. Despite the apparent benefit of microfinance in reducing poverty, an inevitable controversy exists.

Triple Bottom Line Benefits

Entrepreneurship is the active process of recognizing an economic demand in an economy and supplying the factors of production (land, labour and capital) to satisfy the demand usually to generate a profit. High levels of poverty combined with slow economic growth in the formal sector have forced a large part of the developing world’s population into self-employment and informal activities. But this is not necessarily negative, micro enterprises contribute significantly to economic growth. Social stability and equity. The sector is one of the most important vehicles through which low-income people can escape poverty with limited skills and education to compete for formal sector jobs, these men and women find economic opportunities in micro-enterprises as business owners and employees. In most developing countries, micro-enterprises and small scale enterprises account for the majority of firms and large share of employment. In Ecuador, for example, forms with fewer than 50 employees accounted for 99 percent of firms and 55 percent of firms in 1980: in Bangladesh, enterprises with fewer than 100 workers accounted for 99 percent of enterprises and 58 percent of employment in 1986. Finally, it has been noted that small-medium enterprises constitute the most dynamic segment of many transition and developing economics. They are more innovative, faster growing and possibly more profitable as compared to larger sized enterprises. Hence, the role of entrepreneurship in reducing poverty in developing nation is promising. 

Issues, Barriers and Opportunities?

THE ROLE OF SUSTAINABILITY IN REDUCING POVERTY IN DEVELOPING COUNTRIES The concept of sustainability is difficult to define and its precise definition varies within different contexts. However regarding the development process, two primary aspects of sustainability emerge. Economic and environmental sustainability both tie in with the notion of sustainable micro-entrepreneurship, economic sustainability refers to a continual supply of finance to meet a person on community’s needs, usually in the for of secure and accessible loans from a microfinance institutions and environmental is the aim to preserve environmental resources for use by future generations providing financial services entails that they must be sustainable and that means charging interest rates that cover your costs. Microfinance institutions have convincingly demonstrated that they can become profitable and sustainable institutions while making major contributions to poverty reduction by increasing economic opportunities and employment. This affects them because the growing public awareness of corporate governance and of environmental and social issues is driving changes in consumers behaviour. Investment and policy or regulatory adjustments, all signs point to continued pressure on the private sector to demonstrate the economic growth and sustainability.